Have you ever wondered why people don’t save more? Or better yet, have you ever wondered why you can’t save more?

If you continue reading, I’ll tell you why.

The Economy is No Longer an Excuse

It’s extremely easy to blame our lack of savings on “the economy.” Regardless of your age, you have undoubtedly been affected by the Great Recession (and the aftermath). Unemployment and under-employment have been stubbornly high, taxes feel like they’re always going up, and things feel like they’re becoming more expensive.

But, the climate has changed. Unemployment has fallen, employers are beginning to raise wages, and prices (most noticeably oil) have deflated.

If we are being honest with ourselves, the reason we haven’t saved is simpler than the macroeconomic variables listed above. The reason is not macro at all; it’s micro. The reason we cannot save is…us.

Embrace Change to Keep Change

THAT is why increasing our savings is so tough. And THAT is why we fail.

For example, when is the last time you read something like this:

Pack your lunch everyday and stop eating out!

Does this sound familiar? Of course it does. It’s included in every saving and budgeting “how-to” on the internet. But, doesn’t everyone already know that? Is it surprising that paying someone else to cook for you costs more money than cooking yourself? I would guess that 10 out of 10 consumers know that dining out is more costly than dining in.

So why do financial “experts” continue to pound this into our fragile brains? Because it’s important! If you REALLY want to increase your savings, then some sacrifices must be made.

But, it’s also possible to save without changing your habits and behavior. I will actually give you 10 ways to save money without changing your habits and behavior. You will NOT have to STOP anything that you’re doing. You will NOT have to make any sacrifices. And most importantly, you will NOT fail.

All that is required is a maximum of 10-20 minutes per suggestion. With a little research and minimal effort, you can save hundreds of dollars.

10 Ways to Save Money Without Changing Your Habits and Behavior

1. Review your Cell Phone Plan

I am NOT asking you to STOP texting because that would require change. I’m simply asking you to see how many minutes you’re using and how many text messages you’re sending to ensure you’re in the most optimal plan. I was able to save $20 instantly by reducing my data package. I was also able to save $20 by reducing my minutes. If you are maximizing your plan, then don’t change. The penalties for going over would offset any savings.

In addition to reviewing your data usage, you can also look to change mobile carriers. For example, Sprint is promising to slash AT&T and Verizon customers’ bills in half.

2. Review your Car Insurance

I am NOT asking you to drive less or reduce your coverage because that would require change. I am simply asking you to research how much you can save by switching insurance companies. There are several car insurance comparison websites where you can quickly compare quotes. Look for opportunities to bundle (home, auto, etc.) insurance policies together for maximum savings.

3. Review your Bank Accounts

For the most part, if you are incurring overdraft fees from one bank, you will incur overdraft fees from another bank. But, there are several bank fees that are not uniform across all banks. For instance, if you prefer to use an ATM – find a bank that reimburses foreign ATM charges. If you carry a low balance, make sure you’re not being penalized for falling below a certain threshold. Not all banks are created equal, so find one that best fits your needs.

4. Review your Credit Card Rewards Programs

My wife and I have received thousands upon thousands of dollars from our credit card rewards program. Shop around for a card that offers the best rewards for the categories you spend the most money on. A lot of cards will offer 5% cash back on rotating categories. If you’re not keeping up with the changing categories, you may only receive 1%. Whatever program you choose, try to redeem the rewards directly into a savings account…and don’t touch it!

5. Refinance your Mortgage

Thanks to our buddies at the Federal Reserve, interest rates have been at all-time lows. Even if you refinanced your mortgage a few years ago, it could still be beneficial today. Don’t be afraid to crunch the numbers yourself and see how long it will take to recoup any closing costs. While an immediate savings can be recognized by extending your term back to 30 years, try to keep your payment the same and payoff your mortgage sooner.

6. Review your Life Insurance

When was the last time you reviewed your life insurance policy? For most people, it’s never. Mortality tables may have been updated since you initially signed up. I have personally reviewed many outdated policies where the client either reduced their premiums or increased their death benefit (while keeping the cost the same).

7. Open a Flexible Spending Account or Health Savings Account

This is the most under-utilized tax-advantaged account that exists. If you contribute to a FSA or HSA, you can make the usual purchases you make (on health-related expenses), but you’ll be paying with pre-tax dollars. This could mean an instant savings of 15-30% (depending on which tax bracket you fall into).

8. Balance Transfer a Credit Card Balance

Don’t be afraid to open up new lines of credit. I have A LOT of credit cards (that I don’t use) and my credit score is above 800. If, for whatever reason, you’re carrying a credit card balance, then think about transferring the balance to a 0% credit card. There are a lot of good offers if you shop around.

Although an issuer may be offering 0% on the balance, look for any additional balance transfer fees (which can run up to 4%).

9. Review your Health Insurance

You may have limited options depending on your employer. If your employer offers multiple carriers for health insurance, make sure you read through and understand your choices. It’s a natural tendency to choose the most expensive option because it provides the most coverage IF something happens. But, if you’re a healthy person, you’re probably spending more than you need to. If you have a spouse, make sure you’re comparing both of your employers’ options.

10. Ask for a Raise

Out of the 10 ways to save, this is probably the most difficult because it requires an uncomfortable conversation with someone that you’re close with. It won’t be uncomfortable if you go into the conversation prepared. Companies want to keep talented employees and turnover is extremely expensive. If you don’t have specific achievements that you can highlight to your manager, try obtaining an offer from a competing company. After all, one of easiest ways to save more money is to have more money to save.

Related Posts:

Everyone knows that they need to invest, but very few know where, when and how to do so. In an attempt to overcome the paralysis caused by too many investment options, I bring to you a list of sample investment portfolios from the “experts.” I put quotations around the term “experts” because even the most knowledgeable investors of all time will candidly admit to their inability to predict the future. Having said that, these “experts” all agree that selecting an appropriate Asset Allocation is the most important decision you’ll ever make. This decision can greatly minimize risk and maximize returns.

Please keep in mind that I do not recommend any one of the following portfolios over another. My goal was to gather several investment portfolios from “experts” in an effort to give you a better understanding of what a portfolio looks like. It’s important to note that each portfolio mentioned offers varying levels of diversification and, as a result, carries different levels of risk and reward. While I have included specific index funds for convenience, I would recommend consulting with a financial professional prior to investing.

]]>If you ask a friend, neighbor or family member how the stock market has performed over the last 100 years, they’ll all probably give you a similar answer.

“Oh, you know, it’s averaged about 10%.”

While this number is fairly accurate on the surface, it hardly paints the full picture of what kind of future returns an investor can expect. Investors are not entirely oblivious, however, as most understand that the stock market is a volatile place and expect the ride to be more like the middle of a roller-coaster (being swung all around) rather than the smooth ascent at the beginning. But, there is still a misconception that, if one stays the course through the ups and downs, an “average return” will ultimately be achieved.

The problem with this idea is that…

Average Returns are an Illusion

Example 1 (simple illustration):

Let’s say that you have an investment that goes down 50% the first year and up 75% the second year. The “average return” of the 2 years is a positive 12.5%.

(-50 + 75) / 2

That’s simple math, right?

So, if I put in $100 in the first year, I would reasonably expect to have $126.56 after 2 years (even factoring the crazy volatility). However, in all actuality, if I put in $100 in the first year, I would have only ended up with $87.50 after the 2nd year.

Example 2 (real world illustration):

Take a look at these annual returns of the S&P 500 from 1928 to 1941:

43.81%

1928

-8.30%

1929

-25.12%

1930

-43.84%

1931

-8.64%

1932

49.98%

1933

-1.19%

1934

46.74%

1935

31.94%

1936

-35.34%

1937

29.28%

1938

-1.10%

1939

-10.67%

1940

-12.77%

1941

The average annual return over this time period was 3.91%. So, a reasonable investor could have invested $100 in 1928 and expected this $100 to grow by 3.91% each year. However, in reality, $100 invested in 1928 would have been reduced to $93.66 in 1941.

Maybe this discrepancy seems insignificant when using small figures, but what if we’re talking about $1,000,000 and someone’s ability to retire or not? That misconception could be the difference of hundreds of thousands of dollars.

Why does this happen?

Think about it:

If I lose 50% in one year, how much do I have to earn the next year to get back to zero? The correct answer is not 50%, it’s 100%! I would have to double my money just to get back to where I started.

The error arises because simple averages are calculated assuming that results are independent of one another. What makes investing so lucrative, though, is how results from each year are compounded. And, trust me, investment companies that are trying to sell volatile investments fully understand the misinformation they’re presenting. So, what you’ll have to do to combat this misleading marketing is look for (or compute) geometric averages, annualized returns or a compound annual growth rate in place of arithmetic averages.

For those readers that enjoy math and want to know how to calculate geometric averages, you’ll find this to be a helpful calculator.

For those readers that just want to know how this affects you, here are 5 things to keep in mind:

The average annual return of the S&P 500 between 1928-1914 has been 11.53%. The geometric average (the one that matters) has been 9.60%. A big difference over time, but still not too shabby.

Keep in mind that most of these calculations only look at the overall price appreciation and do not account for dividends being reinvested. According to DQYDJ.net, “Since 1950, roughly 89% of your gains would have come from reinvesting your dividends.”

Don’t trust everything you read (this obviously applies to everything but this blog).

Don’t be afraid of math. Only be afraid of math that people calculate for you.

]]>At some point in the last century, leaders from every industry came together and agreed to forego the English language in favor of incomprehensible industry-specific jargon. The main objective was to put up walls around each industry so that “outsiders” would no longer be able to understand what’s going on “inside.” Unfortunately for us, these leaders accomplished their mission and the financial services industry has taken a leadership position in the efforts.

This article is a resource for you – the investor – to decrypt the mumbo jumbo associated with managing your money.

This is everything you need to know about investing…written in plain, easy-to-understand English.

Appreciation

Increase in value or price.

Example: You bought your house for $100,000 and it’s now worth $120,000. Your house appreciated 20%. Or you purchased Walmart’s stock for $40 per share and it’s now selling for $80 per share. Your investment appreciated $40 – or 100%.

Asset

A valuable thing that you own. This can be property, possessions, etc.. Rich Dad, Poor Dad defines this as “something that puts money back into your pocket.”

Example: House, land, a Rolex watch, Apple stock, cash in your wallet

Asset Allocation

The specific mix of assets you own. This is commonly referred to as the MOST IMPORTANT DECISION as it accounts for your goals, the amount of risk you’re comfortable with, and how much time you have to invest.

Example: 60% stocks, 40% bonds

Bonds

You loan money to someone or something hoping that they give you more money back. The money being paid back to you is called “interest.” It’s important to know that as prices rise, interest rates rise and the value of your bond can fall. On the other hand, as interest rates fall, your bond becomes more valuable.

Treasury Bonds – you loan money to the government (the government, while incompetent, has never not paid someone back). And yes, that was a double negative.

Example: I lend a company $10,000 and they promise to pay me $10,000 back plus 5% interest ($500) over 2 years. If interest rates fall a year from now and companies can now borrow at 2% interest, then an investor may want to buy my bond for more than I paid because of the higher interest they would receive.

Brokerage

A place you can go to buy or sell stocks, bonds and other investment things.

Example: TD Ameritrade, Charles Shwab

Commodities

Physical resources that people want or need.

Example: oil, corn, sugar, copper, gold, coffee beans, coal, etc.

Compound Interest

Money that earns more money or “interest on interest.”

Example: If I give my bank $10,000 and they promise to pay me 1% interest, then after 1 year I’ll have $10,100. The following year, under the same agreement, the bank would pay me 1% interest on the $10,100. So, after 2 years, I would have $10,201. I made an extra dollar in the 2nd year I earned interest on my interest.

Depreciation

Decrease in value or price.

Example: If you pay $20,000 for a brand new car, then decide to sell the car to someone else after 1 month of driving it – they may only want to pay you $16,000 because the car is no longer brand new. In this case, your car depreciated 20%.

Dividend

A small portion of a company’s earnings that are paid back to whoever owns their stock.

Example: If you buy Wells Fargo’s (a stable company’s) stock for $55, they’ll likely pay you 2.6% ($1.43) of the share price ($55) every 3 months (quarterly) or every year (annually). You can receive this payment in your bank account or use it to buy more shares of the stock.

ETF

An “Exchange Traded Fund” is like an inexpensive mutual fund or index fund that trades on an exchange – like a stock. Any combination of assets (stocks, bonds, etc.) can be combined to form an ETF.

Example: I recently purchased an ETF that only buys stock of companies that are buying back their own stock. ETFs have gotten pretty exotic.

Index

A bunch of things that represent a certain market.

Dow Jones Industrial Average – represents 30 of the largest companies from various industries

Nasdaq Composite – represents over 3,000 companies – lots of which are technology and internet-related

S&P 500 – represents 500 large companies

Example: The Dow index includes companies such as American Express, AT&T, Walt Disney, Coca Cola and Exxon.

Index Fund

A mutual fund that tracks a certain index. Since an index doesn’t change very often, this is seen as “passive” investing and results in lower fees.

Example: VFIAX is an index fund offered by Vanguard that tracks the S&P 500 index. It only costs .05% annually whereas many mutual funds cost over 1%.

Inflation

An increase in the prices of goods and services.

Example: A gallon of milk used to cost 35 cents, it now costs more than $3.50.

Interest

A fee that someone borrowing money owes to a someone that’s lending money.

Example: If I give my money to a bank, they are technically borrowing it from me and therefore pay me a small fee. If I borrow money from a bank, I pay them a small fee.

IRA

An “individual retirement account” is a place you can set aside some money for whenever you stop working.

Traditional IRA – The government does not tax what you put in now, but it will tax whatever you take out later. This is great if you think you’ll be in a lower tax bracket when you retire. Since you’re receiving a tax break now, you’ll be penalized if you withdraw your money before 59 1/2 years old.

Roth IRA – The government taxes what you put it now, but doesn’t tax anything when you take it out later. This is great if you think you’ll be in a higher tax bracket when you retire. Since you’ve already paid taxes on whatever you put it, you can take this money out penalty-free.

Liability

Mutual Fund

Money that is pooled together and invested in various assets (stocks, bonds, etc.) by a “manager” whose goal is to make you money. This is an “active” form of investing that typically results in high fees.

Example: PIMCO Total Return, one of the largest mutual funds in the world, invests in bonds and costs between .85% and 1.60% annually.

Net Worth

All of your assets (what you own) minus all of your liabilities (what you owe).

Example: If you have $30,000 in your bank account and owe $80,000 on a house worth $100,000; your net worth is $50,000.

Real Estate

Land or buildings.

REIT

A “real estate investment trust” is like a stock that invests directly in properties or mortgages. They’re great because you can buy and sell them very easily – unlike buying actual real estate which is difficult.

Example: You can buy a REIT and own a portion of several shopping malls around the country.

Risk Tolerance

Your ability to handle the ups and downs that come with investing.

Example: If you vomit and swear to never invest again because your investment account value falls from $20,000 to $18,000, then you probably have a “low” risk tolerance.

Stocks

Part ownership of a company.

Blue Chip – stock in a large company with a national reputation (usually pays a dividend)

Growth – stock in a company that is expected to grow more than most other companies (usually doesn’t pay a dividend, but provides appreciation)

Emerging – typically refers to stock in companies based in countries that are somewhat developed, but still growing (Brazil, Russia, India, China)

International – stock in companies outside of the US

Large Cap – stock in companies that are worth more than $10 Billion (Walmart)

Small Cap – stock in smaller companies worth between $300 Million and $2 Billion

Time Horizon

How long until you need your money. The purpose of your money is more important than your age.

Example: A 20-year-old setting money aside for retirement has a long time horizon and can afford to be more aggressive, whereas a 20-year-old setting money aside for a down payment on a house has a shorter time horizon.

401(k)

Basically an Individual Retirement Account (IRA) that the company you work for is in charge of. The money you put in is not immediately taxed and is very often matched by your employer. This money can move with you if you change jobs, but you’ll be penalized if you touch it before you reach 59 1/2 years old. Just like an IRA has a twin-brother named Roth IRA, some companies offer a Roth 401(k) so your money is taxed now and not taxed later.

Example: If you make $50,000 and your employer matches 100% up to 3%; this means that you can put in $1,500 and your employer will put it $1,500, so you’ll have $3,000 saved after 1 year. Also, since you set aside $1,500 – you’ll only have to pay taxes on $48,500 of your income.

It’s fun to spend a Saturday morning ferociously taking aggression out on a helpless little ball with an incredibly engineered stick. Couple that gentleman-like-manliness with some suds (beers) and buds (your 3 best friends), and you have yourself a great start to the weekend. (Scenario A)

On the other hand, that’s hardly how golf goes.

After driving 45 minutes to the nearest course with an available tee-time and dropping $65 minimum, you spend the next 5 hours profusely sweating and pretending to care about the conversation you’re having with Earl – the grandpa that was assigned to your foursome because your best friend was too hung-over show up. Combine that with the confidence you lost in your athletic abilities and the disappointment in your wife’s eyes once you arrive home and say, “honey, I’m exhausted,” and you have yourself a dreadful start to the weekend. (Scenario B)

My most recent golf adventure began as Scenario A (just me and my best friend), but took a CRAZY, UNFORGETTABLE turn that nearly sent me into bankruptcy.

You see, I love to gamble.

Actually, let me rephrase that. I love to gamble on things that I can control – hence why I have never purchased a lottery ticket. If I have no affect over the outcome of the event of which I’m betting on, I have no interest in participating.

So, when my buddy asked me if I wanted to wager “a little something” on the golf round, I was completely up for it because I was in control (or so I thought).

The opening proposal was very harmless. “Let’s bet $1 on every hole,” he said.

I quickly analyzed the odds of the various outcomes, found the maximum loss to be $18 and concluded that the bet would likely result in one of us becoming $6-$12 richer.

I responded, “That bet sounds more boring than women’s basketball!”

My temporarily sexist and chauvinistic tongue followed up with another idea, “Why don’t we bet $1 on the first hole and then double the bet each hole after that?”

My overconfident self assumed that the maximum possible loss would be “a few hundred dollars” while the most realistic outcome would result in one of us becoming $36-$72 richer.

It felt like a more reasonable bet that would keep both parties interested until the end.

The Golf Round

Hole 1 – $1

He wins.

Hole 2 – $2

We tie. (no money exchanged)

Hole 3 – $4

We tie. (no money exchanged)

Hole 4 – $8

He wins.

Hole 5 – $16

I win.

At this point, I’m up $7 and we’re having a blast. The sun is out and the booze is flowing as quickly as the money that’s exchanging hands. In a state of inebriation, we decide to “just finish the round” and “figure out who owes what at the end.” So, that’s exactly what we did.

After shaking hands on the 18th green, we headed into the clubhouse to begin tallying our scores. During the final 3 holes, I entered melt-down mode so I was prepared to write him a check. The question would be for how much. The ensuing conversation went something like this:

Him: “Dude, you’re not going to believe this.”

Me: “Haha, what’s the damage?”

Him: “I don’t think you want to know.”

Me: “Just let me have it. The bet was my idea and a Lannister always pays his debts.” (I tend to quote Game of Thrones in stressful situations)

Needless to say, we were in disbelief. How could something that seemed so small and insignificant turn into such a life-changing figure?

So, we did the math:

$1

$2

$4

$8

$16

$32

$64

$128

$256

$512

$1024

$2048

$4096

$8192

$16,384

$32,768

$65,536

$131,072

Pretty incredible, isn’t it?

If this story was true, I would hope that my friend would ultimately let me off the hook and not mortgage my life. But, while the story may be exaggerated, there is an important lesson that can be taken away.

The Takeaway

Wait, there’s a point to all of this?

When you’re just starting out and investing small sums of money into a retirement account, it’s easy to see your funds as “insignificant.” I used to question how giving up $50 now was going to impact my life 40 years from now. But, thanks to the glory of compound interest (and the rule of 72), your small contributions today will have a substantial impact on tomorrow. If you ever question this mathematical phenomenon and want to decrease your savings, remember how quickly money can accumulate over 18 holes of golf and apply the exponential growth to your rest of your life.

]]>http://funancials.biz/i-almost-went-bankrupt-playing-18-holes-of-golf/feed/0http://funancials.biz/i-almost-went-bankrupt-playing-18-holes-of-golf/Here’s What You Can Learn from the UPS Worker that Never Earned More Than $14,000 Per Year Yet Died with a Net Worth of $70 Millionhttp://feedproxy.google.com/~r/Funancials/~3/ntG_F_FWbNc/
http://funancials.biz/heres-can-learn-ups-worker-never-earned-14000-per-year-yet-died-net-worth-70-million/#respondSat, 07 Feb 2015 04:55:39 +0000http://funancials.biz/?p=2500

]]>“Theodore Johnson worked for UPS and never made more than $14,000 a year and yet, in his old age, was worth more than $70 million. When he said he had no money to save, a friend told him that if he were taxed, the money would be taken out of his account and he’d never see it. So he created a tax for himself to make him wealthy. Even though he made little money, he took 20 percent of his money and it went straight into an investment account. Over more than five decades, that compounded to make him $70 million.”

When I first read this story in Tony Robbin’s new book “Money – Master the Game,” I was baffled. I had to know how someone with such a low income could accumulate such enormous wealth. Could this really just be an incredible example of compound interest? Is this an illustration of what happens when you switch from over-priced mutual funds to low-cost index funds? How could someone that continually lived below the poverty line amass a fortune that catapulted them beyond the 1%? I just don’t get it.

Well, like any good boy, I let it go and didn’t let it bother me relentlessly Googled everything I could until my brain hurt and eyes went cross-eyed. And what did I gain?

Perspective.

The Full Story of Theodore Johnson

It turns out that the story of Theodore Johnson is an old one. Here’s the original New York Times article written in 1991 that highlights Mr. Johnson’s incredible generosity.

According to the story, “Mr. Johnson, who was reared in a middle-class family, worked his way up at U.P.S. to vice president for industrial relations by the time he retired in 1952. His annual salary was $14,000 then, but he had bought as much of the company’s stock as he could and had about $700,000 when he retired.”

At the time the article was written, Mr. Johnson was 90-years-old.

The Glory of Compound Interest

Albert Einstein called compound interest the “greatest mathematical discovery of all time.” It’s the best chance for you and me to become wealthy and – eventually (*sigh*) – retire. The fact that someone can save $3000 a year of their $14,000 income, invest it wisely, and watch it grow into $70 million should be inspiring.

BUT (oh, there’s always a BUT!) , in my opinion, Tony Robbins leaves out some important details. So, in addition to the glory of compound interest…

…Here’s What You Can Learn from the Story of Theodore Johnson

1. Inflation is a b*tch

The way that Tony presents Mr. Johnson’s income is as if it’s nothing – table scraps – because it’s a meager $14,000 a year. This is nothing compared to the median household income of $53,046. If he is able to save 20%, then by-golly we should all be able to. Right? Well, yes, but it’s important to keep in mind that Mr. Johnson retired in 1952. $14,000 in 1952 is not equal to $14,000 in 2015. In fact, after accounting for inflation, Mr. Johnson’s $14,000 equals roughly $123,000. Hmmm…$123,000 a year doesn’t exactly portray the image of poverty that I presume Tony was looking for, does it?

Even though the people that are responsible for fudging reporting government statistics tell us that there is little inflation, there likely will be in the future. So, be sure to protect your wealth by investing in assets that hedge against this deterioration.

2. Diversification is *usually* recommended

When most of us join a new employer, we automatically enroll in their 401(k) program and instantly diversify our investments among several expensive mutual funds that include stocks from large companies, small companies, international companies, bonds, etc.

Mr. Johnson didn’t have a 401(k). These savings vehicles are relatively new concepts – introduced in 1978. So, Mr. Johnson, realizing how important it was to invest, put ALL OF HIS MONEY in his company’s stock. This thankfully worked out very well for Mr. Johnson; but, it could’ve gone horribly wrong. His company just as easily could’ve gone belly-up and his stock could’ve been worth nothing. But, it didn’t, and he looks like a genius.

In Closing

After reading this article, you may assume that I didn’t enjoy Tony Robbin’s new book “Money – Master the Game,” but that couldn’t be further from the truth. I enjoyed it so much that I finished the lengthy book in a weekend. It’s full of a lot of great information that I’ll likely share on Funancials in the near future.

]]>http://funancials.biz/heres-can-learn-ups-worker-never-earned-14000-per-year-yet-died-net-worth-70-million/feed/0http://funancials.biz/heres-can-learn-ups-worker-never-earned-14000-per-year-yet-died-net-worth-70-million/Warren Buffett’s Million Dollar Bet is Good News for You and Charityhttp://feedproxy.google.com/~r/Funancials/~3/qHAwCnGDMng/
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]]>Warren Buffett is one of the most successful investors of all time. His knack for investing in undervalued businesses and watching them grow has landed him on the list of the wealthiest people in the world (fun fact: Warren Buffett’s net worth rose a staggering $37 Million per day in 2013). While becoming one of the wealthiest people in the world himself, he has also helped a number of other wealthy people by allowing them to purchase shares in his holding company, Berkshire Hathaway. The company has averaged an annual growth rate of roughly 20% over the last 49 years while the S&P 500 has averaged 9.8%.

Perhaps what I love most about Warren (yes, we’re on a first-name basis) is what he does for the average investor. Rather than getting a big-head and telling everyone how easy it is to follow in his footsteps and “beat the market,” Warren recognizes the limitations of the average investor. To reiterate Warren’s simple advice from this recent article:

The goal of the non-professional should not be to pick winners – neither he nor his “helpers” can do that – but should rather be to own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 Index Fund will achieve this goal.

Warren put his money where his mouth is by:

1. Ordering the trustee of his will to invest 90% of his fortune in a low-cost index fund from Vanguard.

2. Betting $1 Million that the S&P 500 will outperform hedge funds over a 10 year period.

The Results of the Million Dollar Bet are Good News for You and Charity

According to the website A Long Bet, Warren specifically challenged that:

Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.

Protege Partners, a money manager, accepted the challenge and agreed that the stakes of $1 Million be awarded to the charity of the winners choice.

Warren’s argument:

A lot of very smart people set out to do better than average in securities markets. Call them active investors.

Their opposites, passive investors, will by definition do about average. In aggregate their positions will more or less approximate those of an index fund. Therefore the balance of the universe—the active investors—must do about average as well. However, these investors will incur far greater costs. So, on balance, their aggregate results after these costs will be worse than those of the passive investors.

Costs skyrocket when large annual fees, large performance fees, and active trading costs are all added to the active investor’s equation. Funds of hedge funds accentuate this cost problem because their fees are superimposed on the large fees charged by the hedge funds in which the funds of funds are invested.

A number of smart people are involved in running hedge funds. But to a great extent their efforts are self-neutralizing, and their IQ will not overcome the costs they impose on investors. Investors, on average and over time, will do better with a low-cost index fund than with a group of funds of funds.

Protege’s argument:

Mr. Buffett is correct in his assertion that, on average, active management in a narrowly defined universe like the S&P 500 is destined to underperform market indexes. That is a well-established fact in the context of traditional long-only investment management. But applying the same argument to hedge funds is a bit of an apples-to-oranges comparison.

Having the flexibility to invest both long and short, hedge funds do not set out to beat the market. Rather, they seek to generate positive returns over time regardless of the market environment. They think very differently than do traditional “relative-return” investors, whose primary goal is to beat the market, even when that only means losing less than the market when it falls. For hedge funds, success can mean outperforming the market in lean times, while underperforming in the best of times. Through a cycle, nevertheless, top hedge fund managers have surpassed market returns net of all fees, while assuming less risk as well. We believe such results will continue.

There is a wide gap between the returns of the best hedge funds and the average ones. This differential affords sophisticated institutional investors, among them funds of funds, an opportunity to pick strategies and managers that these investors think will outperform the averages. Funds of funds with the ability to sort the wheat from the chaff will earn returns that amply compensate for the extra layer of fees their clients pay.

The Results (after 7 years)

Through the first seven years, Vanguard’s index fund (tracking the S&P 500) is up 63.5%. Protege’s five hedge funds of funds are up an estimated 19.6% on average. Source

The official scoreboard looks something like this:

Passive Investing: 6

Passive investors will purchase investments with the intention of long-term appreciation and limited maintenance. (Definition from Investopedia)

Active Investing: 1

Active investors purchase investments and continuously monitor their activity in order to exploit profitable conditions. (Definition from Investopedia)

Something to Consider

Unfortunately, the five hedge funds selected for this contest are not disclosed to the public. This greatly limits the usefulness of further analysis since we don’t know how much risk is being taken to achieve such returns. Index funds, while a great investment option during bull markets, provide no protection when times turn sour. On the other hand, hedge funds, in historical terms, are meant to maximize returns while also “hedging” against downside risk. In recent practice, however, hedge funds can carry more risk than the overall market.

Having said that, it’s still good news that you (the average investor) can potentially find the same (if not better) returns than the uber-wealthy by paying less attention to your investments.

Some people think so. And after reading Flash Boys, it’s difficult to disagree.

Michael Lewis (the author) is known for shining light on dark places and bringing transparency to otherwise opaque industries. If his name sounds familiar, it’s because he also wrote The Blind Side, Moneyball, The Big Short and, my personal favorite: Liar’s Poker.

In this recent novel, Michael Lewis examines the investing injustices caused by High Frequency Trading. The details may have faded over the last 6 months since I read the book, but the underlying problem and the thought that “the stock market is rigged” still sits in the back of my mind. I truthfully didn’t love this book enough to recommend it, but a summary may prove useful during your visits to the water cooler.

What you need to know about Flash Boys:

While “trades” used to occur person-to-person on a “trading floor,” most trades nowadays are made electronically by computers and advanced algorithms.

Speed is everything and not all information travels at the same speed. If 2 people uncover news and want to buy the same stock – those 2 orders are not made simultaneously. Being the fastest can be profitable.

Speed matters so much that banks/brokers have tried to place their servers as close to the exchanges as possible. Some have gone to the extremes of burying fiber optic cables in straight lines between New York/New Jersey/Chicago/etc. in order to gain milliseconds. I repeat…milliseconds. Milliseconds = Million$

“Front-running” is the primary concern with varying speeds. If I know that you want to buy a certain stock, I can buy it before you (causing the price to rise) and then sell it to you (for micro-profits).

Our incompetent leaders government (SEC, Senate, etc.) claims that High Frequency Trading provides much needed liquidity in the markets even though there is absolutely no risk taken on by these organizations and there’s potential for billion dollar losses and recoveries (see: Flash Crash) in the span of seconds.

If I piqued your interest, then “go me!” and go read the book. And have fun worrying about all of your wealth disappearing instantly and viewing the stock market as a casino.

Why I Invest in the Stock Market (knowing that it’s rigged)

Now, 393 depressing words later, I’m going to tell you why I am still very bullish on stocks even though I know that someone will steal some pennies from me on each trade. (I tell myself that I’m little affected by high frequency trading because I’m a buy and hold investor, but who am I kidding? They’re robbing me, too.)

1. History

The first disclaimer in every investing pamphlet or prospectus usually reads: “Past Performance Does Not Guarantee Future Results.” It actually makes me laugh because immediately following this disclaimer is “You Should Invest with Us. Look How Well We’ve Done!” Although future results cannot be determined by past performance, history can often serve as a useful tool. I think it was Mark Twain who said: “history doesn’t repeat itself, but it rhymes.”

The rhythm of the stock market is hard to ignore. The trend has noticeably been “up and to the right.” Over long periods of time, the stock market has created vast amounts of wealth. I’ll gladly follow that pattern.

2. Innovation

If they could redo Back to the Future 2 and visit the year 2015, do you think they would show every person staring at their cell phone and complaining about something? Probably not, what a terrible movie that would be! But, aside from our diminishing attention spans, our lives have become extremely easy and productive thanks to continuous innovation and technology. The future that we know about (3D printing, big data, biotech, marijuana) offers some great investing opportunities, but I’m willing to bet that what we don’t know about is even more promising.

3. Inflation

There’s a monster that sneaks into your house every night while you’re sleeping and steals miscellaneous items from you. What’s scary is that the monster is invisible. But, he’s not stealing items and you’re not sleeping. The monster is (hopefully obvious by now) inflation and it’s decreasing your wealth each and every day.

Stocks have, historically, been a great hedge against inflation. Choosing to “do nothing” with your money and losing purchasing power can be combated by higher returns in the stock market – whether it be through stocks, index funds or mutual funds. Since the US dollar is no longer backed by gold, the Federal Reserve can expand our monetary supply to whatever levels they deem appropriate. It’s difficult to feel this impact now as oil prices are falling, but a lot of smart people predict inflation as soon as wages grow.

4. Liquidity

There are other assets – such as real estate, gold, etc. – that also provide a hedge for inflation; but, there are few that offer the simplicity and liquidity of stocks. As the dollar weakens and prices rise, the value of my house will likely rise as well. But, what if I want to sell that house? Or, what if I want to sell a portion of that house? These real estate transaction can be difficult (if not impossible) whereas I can click a button labeled “sell” on TD Ameritrade and transfer the money to my bank account within a day or two.

Readers: Do you think that the stock market is rigged? If so, do you care?

Disclaimer: Someone could just as easily put together an article highlighting why they’re pessimistic about the future of the stock market. They may say that the stock market is due for a pull back because it’s been on an absolute tear over the past 5 years. They may say that rising interest rates may affect PE ratios and investors willingness to pay higher multiples of companies’ earnings for higher potential returns. And they’d be right. But, it’s much more fun to be optimistic than think the sky is falling.

]]>I was 23 years young and I was working my first “real” job (post-college). I still remember the day when my Manager dropped the big binder on my desk labelled “Benefits.” Once I selected my health insurance (hardly knowing what a deductible is), I shuffled through a section titled “401(k).”

I knew the gist of what a 401(k) was, but I wasn’t sure how it operated. To make matters worse, I’m pretty sure it was written in Chinese. The entire experience was overwhelming.

I was asked what I wanted to invest in, what my risk-tolerance was and when I wanted to retire. I remember thinking,

“This is my first day of working and they’re already asking when I want to leave? How does tomorrow sound!?”

Once I filled-in the required fields, there was one last section:

Contributions.

What percentage of my paycheck do I want to contribute towards my 401(k)? In other words, what amount of money can I give up now, so that I will have money when I stop working?

Yikes! What a tough question. I don’t want to give up anything now. That’s so un-American!

Without doing any math and without looking at any budget, I concluded that I could sacrifice 3%. How did I settle on 3%? Easy. It’s in the middle of 1% and 5%.

1% felt too low and 5% seemed too high.

This was an extremely irrational justification. If I actually did the math, I was concerned about losing $28 each month. At the same time, I was nonchalantly dropping $400 each month on bar tabs.

What I’m trying to say is that I wish I would’ve contributed more. Contributing an additional 1% to my 401(k) would NOT have changed my current standard of living, but it would drastically affect my future standard of living.

If you continue reading, I’ll do the math and tell you exactly how much.

How Much Will a 1% Increase of 401(k) Contributions Impact my Retirement Savings?

A lot.

In order to do the math, there are a few assumptions that must be made. We will name our subject: Jack.

Jack is 25 years old and earns $52,000 per year. This breaks down to $2000 per pay-period because he gets paid bi-weekly (26 pay periods). Jack’s employer matches 100%, up to 4%, and he is receiving a raise of 3% each year. Because Jack has decided to invest in the stock market, he expects an average annual return of 8%. Lastly, Jack would like to retire at the age of 65.

100% Match

1% Contribution (compared to no contribution)

Effect to paycheck = $14

Impact on retirement savings = $399,793 compared to $0

2% Contribution (compared to 1% contribution)

Effect to paycheck = $14

Impact on retirement savings = $799,539 compared to $399,793

3% Contribution (compared to 2% contribution)

Effect to paycheck = $14

Impact on retirement savings = $1,199,329 compared to $799,539

4% Contribution (compared to 3% contribution)

Effect to paycheck = $14

Impact on retirement savings = $1,599,093 compared to $1,199,329

Don’t Understand These Numbers?

For every 1% increase in 401(k) contributions, Jack will have $14 less in each paycheck, but will have roughly $400,000 MORE in retirement savings! If Jack goes from contributing nothing to contributing 4%, he will receive $56 less each pay-period, but he will accumulate roughly $1.6 Million by the time he is 65.

So…if I asked YOU to save $112 each month, do you think YOU could do it? What if I told you that, by doing so, YOU would easily become a millionaire?

It’s pretty enticing, isn’t it?

But…

What if Your Employer Does NOT Match Your Contributions?

Well, the first thing you should do is smack politely tap whoever is in-charge and ask, “B*tch, why you ain’t matchin’ my $h!t?” “pardon me, why aren’t you matching my 401(k) contribution?”

I am not going to argue whether you should contribute to a 401(k), an IRA or a Roth IRA. They are all extremely useful and I could make a strong argument for each. In order to be best prepared for any tax environment, you should probably have all three. But, since this article is already focused on 401(k) contributions, let’s stick with that.

No Match

1% Contribution (compared to no contribution)

Effect on paycheck = $14

Impact on retirement savings = $199,896 compared to $0

2% Contribution (compared to 1% contribution)

Effect on paycheck = $14

Impact on retirement savings = $399,769 compared to $199,896

3% Contribution (compared to 2% contribution)

Effect on paycheck = $14

Impact on retirement savings = $599,665 compared to $399,769

4% Contribution (compared to 3% contribution)

Effect on paycheck = $14

Impact on retirement savings = $799,547 compared to $599,665

What Do These Numbers Mean?

By removing the employer match, the effect on Jack’s bi-weekly paycheck is going to be the same. For every 1% increase of contributions, Jack will have $14 less in each paycheck. This equates to roughly $28/month and $364 annually. But, by setting aside $14 each paycheck, Jack is able to have an additional $200,000 in retirement savings.

Summary

Whether you are receiving a match from your employer on your 401(k) contributions or not, I would still recommend contributing as much money as you can. A very small sacrifice NOW will have a very BIG impact later. In the above scenario, a sacrifice of $14 every 2 weeks, will add an additional $200,000 to $400,000 to your nest egg, come age 65.

Why am I wasting $1000 on rent when I could spend $1000 on a mortgage payment?

How many times have you heard this from a friend? Better yet, how many times have you had this thought yourself?

If I can afford an $800 rent payment, I should be able to afford an $800 mortgage payment.

I’ve had this exact thought. My friends and I have had this conversation countless times. I’ve seen this reasoning from everyone, from a Wall Street Investment Banker to a Cashier at the local Fast Food restaurant. It’s very common to think this way, regardless of background or income.

Why would anyone want to throw away money (on rent) when they could buy a house and create wealth (via home equity)?

It’s a very logical question to ask.

But, it’s also very illogical. Making a rent payment is very simple, while buying a home is very complex. What may seem like similar transactions are actually extremely different.

Buying a home can easily create wealth, but it can just as easily destroy it.

If your justification for buying a house is that your current rent payment could cover a similar mortgage payment, I recommend you rethink your decision.

Your Rent Payment is NOT Comparable to a Mortgage Payment

Just because you can afford an $800 rent payment, does NOT mean that you can afford an $800 mortgage payment.

Your $800 rent payment is equivalent to a $400 mortgage payment. If this seems like a drastic difference to you, it’s because owning a home is drastically different from renting a home. I will walk you through the differences between rent payments and mortgage payments below.

If you are paying $800, your initial thought is that you can afford a mortgage payment of $800. If you do some simple math or plug numbers into a mortgage calculator, you’ll find that financing $150,000 will give you a mortgage payment of about $800. You see this and begin looking at houses that cost $150,000;

but, wait!

What About Taxes and Insurance?

Each year, you are required to pay taxes on the property that you own. The amount of this tax depends on where you live. It could range from .2% to 2%. Some homeowners decide to make this payment with their monthly mortgage payment, while other homeowners choose to pay their taxes annually.

In addition to the taxes, you will also have to maintain insurance on your property. Again, you can combine this payment with your taxes (usually referred to as escrow) and your monthly mortgage payment.

It’s always best to look up tax rates in your area, but I estimate 1.25% of the property value for taxes. Insurance will be about .5% on top of that.

After factoring in taxes and insurance, the $150,000 house that you were eyeing is suddenly out of your price range. Now you’re looking at a price of about $115,000. Here’s how I concluded that:

$115,000 financed for 30 years at 5%

Mortgage Payment: $617

Taxes: $120

Insurance: $50

Approximate Monthly Payment: $787

Your $800 rent payment is now comparable to a $600 mortgage payment.

But, wait!

What About Maintenance Costs?

When you are renting a home or apartment, your landlord is (or should be) a phone call away. If something breaks, they will fix it. If something stops working, they will replace it. Unless you are the one that caused the damage, your landlord covers all maintenance and repair costs. This is one of the rudest awakenings when it comes to buying a home.

Regardless of the age of your house, you can expect something to break or stop working. My house is relatively new (born 1993) and there is always an unexpected expense of some kind. If you want to estimate what this expense could be, there are 2 decent approximations.

What You Can Expect to Pay for Monthly Home Repairs and Maintenance

1% of your home’s value

(If you live in a $150,000 home, you can expect to spend $125/month on repairs and maintenance.)

25% of your mortgage payment

(If your mortgage payment is $800, you can expect to pay $200/month on repairs and maintenance.)

Neither estimation is perfect, but it’s a place to start. When in doubt, assume it will cost more.

After factoring in monthly home repairs and maintenance, the $115,000 house that you were eyeing is suddenly out of your price range. Now you’re looking at a price of about $95,000. Here’s how I concluded that:

$95,000 financed for 30 years @ 5%

Monthly Mortgage Payment: $510

Taxes: $99

Insurance: $40

Monthly Maintenance: $128

Approximate Monthly Payment: $777

(*The taxes and insurance at this point are underestimations)

Your $800 rent payment is now comparable to a $500 mortgage payment.

But, wait!

What About a Down Payment?

Traditionally, mortgages have been 80/20. This means that the lender will finance 80% of the home if you put down 20%. In other words, you would be required to have $20,000 as a down payment if you wish to buy a home priced at $100,000.

If you want to set yourself up for success, I would recommend following this tradition.

If you do not have 20% to put down, there are other financing options available. With a FHA (Federal Housing Administration) loan, you may only be required to put down 3.5%. In order to purchase the same $100,000 house, you only need to put down $3,500.

What About Private Mortgage Insurance?

If you only make a down payment of $3,500 on a $100,000; then your mortgage balance will be $96,500. Since the value of the collateral (house) is so close to the loan amount, you will be required to pay Private Mortgage Insurance (PMI) to insure the lender against default (if you stop paying). You will be required to pay this insurance each month until your Loan-to-Value (LTV) is less than 80%. Therefore, once the balance that you owe drops below $80,000, you will (likely) no longer be required to pay this premium.

In order to stay true to the example in this article, we are looking at homes priced at $95,000. Therefore, a down payment of $3,325 would be required. The PMI that you would have to pay monthly is about $88.

After factoring in a down payment and private mortgage insurance, the $95,000 house that you were eyeing is suddenly out of your price range. Now you’re looking at a price of about $85,000. Here’s how I concluded that:

$85,000 financed for 30 years @ 5%

Monthly Mortgage Payment: $456

Taxes: $89

Insurance: $35

Monthly Maintenance: $114

Down Payment: $2,975

Private Mortgage Insurance: $79

Approximate Monthly Payment: $773

Your $800 rent payment is now comparable to a $400 mortgage payment.

Summary

Buying a house is a HUGE decision. Just because you are comfortable with your rent payment does not mean that you’ll be comfortable with a similar mortgage payment. There are so many costs associated with buying and maintaining a home that you never see while renting a home. Before you take the plunge into home ownership, please consider what I said earlier:

Buying a home can quickly create wealth, but it can destroy it just as quickly.